The Debt-to-Equity Ratio (D/E Ratio) is a measure of finance that indicates the relationship between a company's total debt and its total shareholder equity. It reflects the amount of debt a company is employing to fund its business in proportion to the shareholders' investment.
It is an important measure of financial leverage and risk.
Debt-to-Equity Ratio = Total Debt/Shareholders' Equity
Suppose a company has:
Total Debt = ₹50 crore
Shareholders' Equity = ₹25 crore
Then,
D/E Ratio= ₹50 crore/₹25 crore = 2.0
It implies that the company has ₹2 of debt for each ₹1 of equity.
The ideal D/E ratio varies by industry:
Industry | Typical D/E Ratio Range |
---|---|
Tech / Services | 0.2 – 0.5 |
Manufacturing | 1.0 – 1.5 |
Infrastructure | 2.0 or more |
D/E < 1: Company is employing more equity compared to debt → Less financial risk.
D/E = 1: Equally financed by debt and equity.
D/E > 1: Firm is employing excess debt over equity → Increased financial risk but potentially greater returns.
Risk Assessment
Excessive debt can stretch a firm's finances, particularly when profits decline.
Creditworthiness
Banks utilize it to gauge the firm's repayment capability of loans.
Investor Insight
Indicates the extent of aggression of the firm in employing borrowed capital.
Capital Structure Decisions
Assists management in making the correct proportion of debt and equity financing.